Breaking Laws in the Mortgage Bubble

The government won a big victory this week in a case against two banks that were found to have systematically deceived investors about shoddy mortgage securities they peddled during the housing bubble. “The magnitude of falsity, conservatively measured, is enormous,” wrote Judge Denise Cote of Federal District Court in Manhattan in a strongly worded 361-page ruling.

The banks are Nomura Holdings of Japan and the Royal Bank of Scotland. The investors are Fannie Mae and Freddie Mac, the government-run mortgage agencies. The case was brought by the Federal Housing Finance Agency, the overseer of Fannie and Freddie.

The government’s victory in this case raises an interesting question: If the relatively unknown housing finance agency could prevail over foreign banks, why haven’t far more powerful regulators and prosecutors at the Department of Justice and the Securities and Exchange Commission done more to expose and redress wrongdoing by big Wall Street banks in the mortgage bubble?

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A judge ruled that the Royal Bank of Scotland misled investors during the housing bubble.CreditWarren Allott/Agence France-Presse — Getty Images

The post-bubble role of the housing finance agency has been important but relatively narrow: to recoup losses attributable to securities law violations and, in some cases, fraud by banks that sold mortgages to Fannie and Freddie. It has settled most of its suits, and it went to court against Nomura and R.B.S. when the two refused to settle. Assuming an expected appeal fails, the banks will owe damages estimated at about $500 million.

The Justice Department and the S.E.C., by contrast, have a broader obligation to enforce rights and laws and to punish and deter wrongdoing, a mission that comes with vast investigatory and enforcement powers. Yet in cases involving major banks and the mortgage bubble, they have acted as if their main job is to extract fines. They have relied almost exclusively on big settlements without demanding accountability. Banks have rarely been required to admit wrongdoing, and names have rarely been named.

Moreover, the Justice Department has approached the process in a way that has sidestepped the need for a judge to sign off on the mortgage-related settlements, a procedure intended to ensure that settlement deals are in the public interest.

The trial against Nomura and R.B.S. rebuts the widespread notion that banks’ greed during the bubble did not amount to lawbreaking, that somehow it was the housing crash, and not deceptive practices, that caused the bonds to collapse. And it is a reminder that the banks that settled, by avoiding a detailed public airing of their conduct, have been shielded from full accountability for the consequences of their behavior. This does not bode well for the stability of the economy or the rule of law.